Plan’s Costs Far Outweigh Its Benefits

Chye-Ching Huang is a federal tax policy analyst with the Center on Budget and Policy Priorities.

Updated September 30, 2013, 5:19 PM

When considering whether to eliminate taxes on capital gains, dividends and interest, we must ask: do the benefits outweigh the costs?

The costs are clear. Tax rates on capital gains and dividends that are lower than those on ordinary income encourage tax lawyers and accountants to create schemes to transform, on paper, “ordinary income” into capital gains and dividends. Time, talent and resources that could be used productively are instead poured into tax avoidance, creating a drain on the economy.

Ending capital taxes would increase debt and inequality and result in little or no economic growth.

Proponents claim that lower capital gains and dividends rates help boost the economy, but the evidence doesn’t show it. In 2003, President Bush and Congress cut the tax rate on capital gains and dividends to 15 percent (ceasing to tax dividends at the same rate as salary and wage income). If the proponents were right, we would have expected U.S. stocks to then perform much better relative to European stocks, whose owners didn’t get such a tax cut. But research found that they didn’t.

Moreover, cutting capital gains and dividends rates below ordinary income tax rates, if financed by more government deficits, can decrease national savings and investment. Indeed there’s no evidence that the tax breaks for capital gains and dividends contribute to economic growth at all, let alone by enough to outweigh their costs.

In addition, such tax breaks are inequitable. Tax Policy Center data show that in 2011, households with incomes between $100,000 and $200,000 that got more than two-thirds of their income from investments taxed at the preferential rates owe an average of 5 percent of their incomes in federal income and payroll taxes. But, households that earned the same total income, but with less than one-tenth of it from investments taxed at the lower rates, faced an effective tax rate of 19.2 percent — nearly four times higher. And because investment income is so concentrated at the top of the income scale, these tax breaks exacerbate the problem of high — and growing — income inequality.

By eliminating all taxes on income from investments, the Ryan Roadmap would exacerbate these inequities, giving the richest one-tenth of one percent of people a tax cut of $1.7 million on average, according to the Tax Policy Center. Some of America’s wealthiest people would pay not a penny of tax on their dividend checks or stock gains.

In the interest of equity, efficiency and the public purse, costly tax breaks on investment income should be reduced or eliminated – not expanded.